Dow Jones Newswirz

By Simeon Kerr
20th November 2001 - Dow Jones International News

Iran's new-look economy ready for Russian oil price war

DUBAI -(Dow Jones)- Thanks to bumper oil prices and slick macroeconomic management, Iran's once-creaking economy has turned a corner - so Tehran is well placed to wage the Organization of Petroleum Exporting Countries' price war against Russia. OPEC is driving down the oil price to secure an output cut from recalcitrant Russia, in order to mop up a global crude overhang and in time to revive flagging oil prices. The OPEC crude oil basket averaged $15.85 a barrel Monday.

For Iran, along with many OPEC producers, this is a risky strategy: 80% of government revenue is derived from its abundant oil fields. Last fiscal year - March 2000-March 2001 - an average oil price of $23 a barrel translated into the largest annual oil revenue in Iran's history - around $25 billion. This year, oil revenue could dip below $20 billion, according to Economist Intelligence Unit forecasts.

Most observers, though, remain sanguine. "Two years ago, Iran would have had all kinds of deep problems (with lower oil prices), but they're quite well placed now," says Simon Williams of the EIU.

That's partly because President Mohammed Khatami's tenure has been blessed by a period of mainly buoyant oil prices, which along with prudent fiscal policies, has planted the seeds of a flourishing economy, analysts said.

In 1997, when Khatami unexpectedly swept to power, Iran was in the midst of a debt-repayment crisis. Khatami's predecessor, former President Ali Akbar Hashemi Rafsanjani, had built up a mountain of short-term debt while reconstructing the country out of the ruins of the 1980s Iraq-Iran war.

In 1996, short-term debt servicing costs stood at $6.5 billion; by this year they were down to $2.5 billion, with 2002 projected at $2 billion, and 2003 at $1.5 billion.

Another contribution to economic stability was the creation of the oil stabilization fund in March 2000. The government funnels oil revenues over and above annual budgeted oil income into the fund. Half of the fund is kept as a hedge against fluctuating oil prices; the other half is used to fund the development of the non-oil private sector, as well as public sector infrastructure projects.

The oil stabilization fund, according to Atieh Bahar Consultants, a Tehran-based business consultancy, has swelled to at least $8 billion to $9 billion, thanks largely to oil prices soaring above the conservative budget assumptions last year.

The budget assumes an oil price of $16/bbl this fiscal year, and will use the same price next year, according to Atieh Bahar. "So even if the price drops to an average of $16/bbl, there's still a $4 billion buffer," said Siamak Namazi of Atieh Bahar.

The central bank's foreign exchange reserves, which have swelled to an estimated $8 billion to $11 billion over the past three years, further pad out the fiscal cushion.

That buffer gives Iranian officials confidence in their economy's ability to weather plunging oil revenues. One told a Tehran-based diplomat that the government could meet its budgetary commitments, without dipping into foreign reserves, if the price of Iranian crude averages $12.80/bbl next year.

Foreign observers, too, have faith in the current Iranian government's financial acumen and the fortuitous timing of this oil price fall. "No oil price is going to put Iran in the disastrous position it was in during the Iran-Iraq war - and the country came through that okay," a western banker with extensive experience in Iran said.

"The economy is centrally-controlled, so the government has the ability to batten down the hatches during tough times," he added.

The banker also played down speculation that an economic downturn would stir up Iran's ever-present undercurrent of popular dissent to levels that could unravel the fabric of the Islamic republic.

"The regime is a past master at using political and economic leverage to keep matters from spiraling out of control," he said. "It's true that the regime can't manage the expectations of the younger generation, but those expectations have yet to boil over."

While many Iranians are frustrated with the snail-pace of political and social reform - largely because of the regime conservatives' determination to defend the status quo - their enduring faith in the hugely popular Khatami has kept a lid on unrest, observers said.

Still, internal economic problems can only magnify other grievances, observers said. "The economy is much stronger these days - but it still needs to improve dramatically in order to meet the job creation target," said Namazi. "There are just too many young people with too much time on their hands."

Unemployment - officially pegged at 13%, but reaching as high as 30% in some parts of the country, is the real worry. The government's own figures illustrate the depth of the problem, diplomats said. Some 800,000 jobs are needed for Iranians entering the labor pool every year, but only 340,000 jobs were created last year.

That shortfall brings the oil price back into sharp focus: healthy oil revenues, through the oil stabilization fund, help finance the government's economic reform strategy, which hinges on reviving the moribund private sector through foreign and domestic investment.

© 2003 All Rights Reserved. Atieh Bahar Consulting.